Must distribute most of the earnings to unit holders (interest, dividends, net realized capital gains, net unrealized capital gains)

Basics

• investors who share a mutual investment objectives pool their money
• professional fund managers buy/sell securities for the fund's portfolio
• open-ended: sells new units, buys back existing units —> liquid
• unit holder may have voting rights in the funds held
• Net Asset Value = (Net Assets - Liabilities)/(Number of Units Outstanding)
• fund pledges to buy units for the Net Asset Value at the time of redemption
  • called the unit holder's right of withdrawal or redemption

Advantages

• clear investment objectives
• professional management
• economies of scale
• diversification
• small minimum investments
• access to complex investments
• liquidity
• eligible for RRSPs, RRIFs, RESPs
• choice of many funds and types of funds
• easy to buy/sell

Disadvantages

• expenses: sales charges (loads), management fees
• long-term time horizon (not for emergency cash)
• liquidity
  • redemption of units can be suspended
  • payment of interest or dividends can be postponed
• market risk
  • stock market down then market value of equity mutual funds down
  • bond market down then net asset value of bond mutual funds down

Fees

There are three fee structures

1. no load
   • “level load”: trailer feed built into the total management fee
   • fees and charges spread evenly over life of contract
2. frontend load
   • reduces the net investment (e.g., 4% of purchase amount means that only 96% is invested)
3. backend load (no effect on daily performance; often declines and may disappear)
   1. redemption fee
      • e.g., 5% of original investment or redemption proceeds
   2. deferred sales charge
      • e.g., 4% in year 1, 3% in year 2,…, 0% in years 5+

Formulas

Net Asset Value per Share = {(Fair Market Value of Total Assets) - (Fair Market Value of Total Liabilities)}/(number of shares issued)

• usually calculated daily after market closes

Taxation

• returns (interest, dividends, or capital gains) are passed to unitholders
  • so no corporate tax to the fund company
• annual taxation on the returns
• interest credited monthly or quarterly
• dividends credited quarterly, semiannually or on December 31
• capital gains
  • from buying/selling by the fund managers or from buying/selling units
• capital losses
  • remain with in the fund portfolio to offset capital gains → not passed on to unitholders
  • upon selling units, investors may receive capital losses
    • can apply against capital gains (but not against any other income)